From Flashbots

Wallets are the gateway to Web3, serving as essential portals for users to send and receive messages, manage funds, and interact with blockchain applications. As a critical piece of blockchain infrastructure, wallets significantly shape users' Web3 experiences.

The wallet ecosystem is diverse, with providers offering varied products and services through different mechanisms. As wallet providers strive for sustainability and diversification, their operational models are evolving, creating new dynamics between users, applications, and the underlying blockchain infrastructure.

Our report aims to illuminate the current state of wallets on Ethereum, building upon the research conducted by orderflow.art.

However, identifying wallets through on-chain transaction tracking presents several challenges:

Despite these limitations, this report provides a comprehensive overview of the Ethereum wallet landscape, its current trends, and future prospects.

The report begins with a Background section covering two key areas: Wallet Taxonomy and the Order Flow Lifecycle. In Wallet Taxonomy, we categorize Web3 wallets into custodial and non-custodial types, detailing the various forms of non-custodial wallets. The Order Flow Lifecycle section outlines the journey of a transaction, identifying key players from Order Flow Originators to block builders.

Next, we explore Current Trends, focusing on recent developments affecting Order Flow Originators (OFOs). We examine the implications of increasing centralization in the block building market, which has intensified competition for order flow. This section covers three key concepts: Payment for Order Flow (PFOF), Order Flow Auctions (OFAs), and Private Order Flow (POF). Additionally, we introduce Account Abstraction (AA), with a particular focus on ERC-4337, a significant development reshaping the wallet landscape.

Finally, in Future Trends, we explore developments aimed at enhancing user experience and addressing regulatory challenges in the wallet landscape. We examine pre-confirmations (pre-confs), a mechanism designed to improve transaction confirmation speed. We also analyze two Ethereum Improvement Proposals (EIPs) that seek to enhance Account Abstraction capabilities. Additionally, we discuss Trusted Execution Environments (TEEs) and their role in improving security and privacy for Web3 wallets. We consider how TEEs might serve as a potential compliance solution for the crypto industry, particularly as regulatory focus shifts from decentralization to questions of control.

Background#

Introduction#

Wallets serve as the primary interface for users to interact with blockchain applications. While users often maintain multiple wallets (for example, several MetaMask accounts), the process of migrating private keys to a new wallet provider is typically cumbersome. This lack of user-friendly portability creates a 'stickiness' effect, often keeping users tied to their existing wallet providers.

The intensifying competition for order flow has heightened the importance of user acquisition and retention for wallet providers. This competitive landscape has led to an interesting development: decentralized finance (DeFi) applications, such as Uniswap, 1inch, and Curve Finance, are now creating their own wallets. This strategic move allows these DeFi platforms to exert greater control over their users' order flow, potentially capturing more value and providing a more integrated user experience.

This trend underscores the evolving relationships between users, wallets, and DeFi applications in the blockchain ecosystem. It highlights how the battle for order flow is reshaping the wallet landscape and influencing the strategies of major players in the DeFi space.

Figure1.Overview of Ethereum wallet ecosytem

Wallet Taxonomy#

Web3 wallets are usually categorized as either custodial, controlled by third parties, or non-custodial, controlled by the user. Control is defined as who holds the private keys to the wallet.

There are different types of non-custodial wallets with varying technology to improve user experience and security.

MPC Wallets#

Multi-Party Computation (MPC) wallets use cryptography techniques to encrypt, fragment, and distribute private keys to multiple devices. These devices or parties must evaluate a computation without revealing their private keys or data. A multi-party computation protocol used in the context of MPC wallets usually has these properties:

The benefits of MPC wallets are:

Externally Owned Accounts (EOAs)#

Externally Owned Accounts (EOAs) are managed by unique private keys that users control to interact with smart contracts on-chain.

EOAs use a private Elliptic Curve Digital Signature Algorithm (ECDSA) key to sign and verify digital transactions. Users can send and receive transactions, interact with smart contracts, and approve messages through EOAs.

To create an EOA, a wallet UI generates a private key and a seed phrase. Because of the singular private key and seed phrase, a user will lose access to their wallet if they lose both their private key and seed phrase.

Smart Contract Wallets#

Smart contract wallets, or smart wallets, utilize Account Abstraction and the programmability of smart contracts to improve user experience. Smart contract wallets are not controlled by a private key but by the contract code. Account Abstraction protocol like ERC-4337 helps smart contract wallets bypass the requirement that an EOA wallet initiates a transaction. Smart contract wallets can be programmed for features such as:

Compared to EOAs, smart contract wallets have a small gas overhead mainly due to the execution of contract code and the publishing of events. Smart contracts are inherently more complex and powerful relative to EOAs, so only audited and battle-tested smart contract wallets should be trusted.

Order Flow Lifecycle#

Orderflow.art illuminated the order flow landscape and identified the known on-chain actors in a transactionʻs lifecycle.

A transactionʻs life cycle begins on the left-hand side of the order flow Sankey with on-chain frontends and ends on the right-hand side with block builders.

Figure2.Edited Orderflow.art Sankey from September 30, 2024

The key on-chain actors in a transactionʻs lifecycle are:

Order Flow Originators#

Order Flow Originators (OFOs) are the first on-chain applications that interact with a wallet. OFOs include:

Figure3.Frontend Trading Volume (3 years), Dune Analytics. September 30, 2024.

Figure4.Frontend Transaction Count (3 years), Dune Analytics. September 30, 2024.

Figure5.Frontend Trade Sizes (7 days), Dune Analytics. September 30, 2024.

Liquidity Providers#

Large transactions or those involving illiquid trading pairs are often routed to Order Flow Auctions (OFAs) and aggregators to minimize slippage. These providers source liquidity from multiple decentralized exchanges (DEXs), off-chain sources, and proprietary inventories.

Mempools#

Ethereum orders are submitted to either public or private mempools:

Builders#

Builders arrange and include transactions in a block. The order's lifecycle is complete if the transaction is included in the winning builder's block. If not included in the winning block, the transaction remains in the mempool until it is either included in a future block or discarded.

References#

Current Trends#

The Ethereum landscape is currently characterized by several significant trends that are reshaping the industry. Two major trends in Ethereum that affect Order Flow Originators are 1) the centralization of the block-building market, and 2) the implementation of Account Abstraction with ERC-4337.

Block Builder Centralization#

Ethereumʻs builder market has become increasingly centralized with two builders capturing more than 90% of the block market.

Figure 6. 30-day builder market share from September 30, 2024, libmev.com.

This concentration has given rise to new dynamics in order flow:

These mechanisms are transforming how transactions are processed and prioritized, offering benefits like MEV protection and improved price discovery, but also raising concerns about market fairness and decentralization

Payment for Order Flow#

Payment for Order Flow (”PFOF”) is a traditional finance concept that started with market makers paying brokerages for their OTC order flow. Market makers consider retail order flow uninformed and non-toxic and are highly profitable to trade against. As automated trading systems (”ATS”) expanded, market makers used PFOF to attract retail order flow to their ATS.

Retail traders benefit from PFOF in three ways:

In Ethereum, PFOF has emerged as Exclusive Order Flow (”EOF”) relationships between Order Flow Originators (”OFOs”) and Builders. EOF bypasses the public mempool and accounts for as much as 35% of the market. Exclusive Order Flow enables a builder to construct a higher value block than competitors constrained to sourcing transactions from the public mempool or Order Flow Auctions (”OFA”). Because EOFs require execution guarantees, builders will multiplex the OFOʻs bundle to guarantee timely inclusion.

There are several reasons why Order Flow Originators utilize EOF relationships:

Currently known EOF relationships:

Figure7.Banana Gun EOF blocks*.

Figure8.Banana Gun multiplexed blocks.

Figure9.Maestro EOF blocks.

Figure10.Maestro multiplexed blocks.

*EOF is approximated by order flow not seen by Flashbots or in the mempool.

Order Flow Auctions#

Order Flow Auctions (OFAs) were created to protect user transactions from negative MEV strategies such as front-running and sandwich attacks. OFAs offer many benefits to users including:

Figure 11. MEV supply chain with Order Flow Auctions.

OFAs aggregate swap transactions from multiple users and auction them to third-party bidders for execution. OFAs function as the auctioneers and select winning bids on predefined criteria. The winning bids are submitted on-chain in a bundle to block builders for consensus.

There are different types of OFAs:

Private Order Flow#

Private Order Flow (POF) is the order flow from vertically integrated order flow originators (wallets, applications, solvers, searchers) and builders. This flow is typically not multiplexed and sent to a singular builder.

The top builders, Beaver Build and Rsync, are integrated with proprietary trading firms SCP and Wintermute and benefit from internal CEX-DEX order flow. Integrated searcher-builders have an advantage over normal builders since profits from their searcher can be reallocated to their builder increasing their likelihood of submitting the winning block bid. Integrated searcher-builders also benefit from latency savings when sending their transaction from the searcher to the builder. This latency savings can then be extended to the block builder auction.

Figure12.Exclusive Order Flow (EOF) from the seven most prominent EOF providers based on total value.

(a) https://arxiv.org/pdf/2407.13931. EOF for Titan (b), Beaverbuild (c), and Rsync builders (d). Note that only Rsync sees Wintermute private order flow and only Beaverbuild sees SCP private order flow.

Future Implications#

OFAs like Flashbots Protect and MEV-Blocker have provided RPCs for users to integrate into their wallets. These products were primarily opt-in for individual wallet users and directly integrated into applications.

Moreover, wallets have started to capture the value of their order flow.

References#

Account Abstraction#

The implementation of Account Abstraction, particularly through ERC-4337, is revolutionizing user interactions with blockchain networks by introducing smart contract wallets and new entities like Bundlers and Paymasters. These developments are not only enhancing user experience but also creating new opportunities and challenges in transaction processing and fee structures.

ERC-4337#

The key goals of account abstraction are to remove the need for all users to have an EOA and to allow users to use smart contract wallets as their primary account. Account abstraction accomplishes this by separating account management and transaction execution from EOAs. Account abstraction uses new entities: 1) the Bundler, to initiate transactions and 2) the Paymaster, to determine the gas payment policies.

Figure 13. ERC-4337 workflow stream

ERC-4337 introduces two new parties - the Bundler and the Paymaster:

Figure 14. Weekly Active Smart Accounts

Figure 15. Weekly Bundler Revenue

Figure 16. Weekly Paymaster Gas Spend

Future Implications#

Under ERC-4337, the Bundler is in a similar position to todayʻs block builder and can execute exclusive order flow deals with smart contract wallets. Exclusive order flow is more important to Bundlers because they compete for the highest priority fee and losing Bundlers pay for the gas cost of reverting UserOperation.

Because the UserOperation mempool is public, UserOperations are susceptible to MEV from front-running and sandwich attacks. Bundlers can capture a portion of this MEV since they order and batch the UserOperations into a bundle transaction. Searchers could run Bundlers to extract MEV from the public UserOperation mempool. Bundlers and Builders could integrate to obtain additional order flow.

References#

Future Trends#

The cryptocurrency and blockchain landscape is on the cusp of significant transformation, driven by technological innovations and regulatory developments. Key trends shaping the future include:

As the focus shifts from broad decentralization to nuanced discussions of control and execution, these trends collectively promise to redefine how users interact with blockchain networks, how developers build applications, and how the ecosystem navigates regulatory challenges.

Preconfirmations#

Preconfimations (”preconfs”) is a research proposal that allows users to receive a transaction confirmation before their transaction is confirmed in consensus. Preconfs aim to improve the user experience by eliminating high network congestion on Ethereum, layer 2 rollups, and validiums through faster confirmations. First introduced by Justin Drake, based preconfs allow L1 proposers to provide economic guarantees that an L2 user transaction will be included.

Figure 17. Based Preconfirmations for Rollups

How do preconfs work?#

The preconfirmation landscape is still in its early stages and several different methodologies have been proposed. These are the few that could affect order flow originators the most:

Future Implications#

Preconfs will lead to a better execution experience since order flow originators can guarantee transaction execution for higher fees.

In the case of XGA-style preconfs, bottom-of-the-block inclusion for non-latency-sensitive transactions (i.e. “governance”, ”staking”, “authorizations”, “claiming”) can lower the gas spent on these transactions and reduce the number of transaction reverts from insufficient gas.

References#

EIP-7702 and EIP-7212#

There are two Account Abstraction EIPs that could fully unlock the potential of smart contract wallets and become game-changers for the wallet ecosystem.

EIP-7702#

EIP-7702 introduces the following features to EOAs:

EIP-7702 is designed to be backward and forward compatible with ERC-4337 allowing EOAs to take advantage of the existing ERC-4337 infrastructure. EOAs can also temporarily convert themselves into smart contract wallets for inclusion in ERC-4337 bundles.

Benefits of EIP-7702 include:

EIP-7702 is still a new proposal and has a few issues that developers need to consider:

EIP-7212#

EIP-7212, or RIP-7212, creates a contract for signature verification using the “secp256r1” elliptic curve standard. This standard has been adopted for user authentication by the largest Web2 corporations and can be integrated into ERC-4337ʻs smart contract wallets.

“secp256r1” is currently used in the following authentication applications:

RIP-7212 is the roll-up version of EIP-7212 and teams from Kakarot, Polygon, Optimism, zkSync, Scroll, and Arbitrum have already committed to implementation. Polygon has RIP-7212 available on their testnet and Coinbaseʻs recently launched Smart Wallets include passkey authentication.

Figure18.Mobile authentication via passkeys

How do passkeys work?#

Future Implications#

While EIP-7702 is still a proposal, RIP-7212 is being actively integrated into L2 roll-ups and implemented into smart contract wallets. Passkey wallets supercharge ERC-4337 smart wallets by eliminating the need for passwords and seed phrases and elevating security to a hardware level. Current projects featuring passkeys include:

References#

EIP-712#

EIP-712 is a standard for typed message signing which aims to allow off-chain message signing for on-chain signing allowing for a better user experience. Rather than reading byte strings, EIP-712 enables signatures to be displayed in a readable format without losing system security properties. Off-chain signing saves gas and reduces the number of transactions on-chain.

Figure19.Current message signature

Figure20.Message signature with EIP-712

How does EIP-712 work?#

One of the key features that EIP-712 unlocks is that it allows dApps to control the transaction flow for users rather than wallets. Applications like Uniswap, can minimize their usersʻ MEV since swaps would bypass OFAs and other MEV value extractors.

Figure21.Uniswapʻs interest in transaction flow control

In addition to wallet transaction readability, EIP-712 improves governance usability by allowing a third party to pay the gas fees for user votes. Voters can use EIP-712ʻs by-signature functionality to create a signed delegate or vote transaction for free.

Future Implications#

In addition to wallet readability, EIP-712 can be used to improve the user experience in other areas.

References#

Trusted Execution Environments (TEEs)#

Trusted Execution Environments (TEEs) is a secure enclave based within a hardware microprocessor where sensitive computations and operations can run with integrity and privacy. TEEs support isolation and remote attestation and can run virtual machines like EVM and CosmWasm without the cryptographic overhead like Multi-Party Computation (MPC) or zkSNARKs.

For web3 wallets, mobile TEEs like Appleʻs Secure Enclave and Googleʻs Titan M2 can secure smart contract walletʻs private keys better than standard hardware wallets. Users can create and store a private key inside a TEE and sign transactions from these keys. The keys remain on the device and can only be accessed by the device owner via biometric authentication or device PIN.

TEEs are currently used in several wallet solutions:

Future Implications#

TEEs are poised to be a major game changer for blockchains.

References:

Execution, Control, & Decentralization#

One of the major challenges for wallet providers has been educating users and regulators about self-custody and on-chain accounts. However, as the web3 ecosystem has matured, key stakeholders have come to understand several crucial points:

This growing understanding has been crucial in clarifying the role of wallets in the cryptocurrency ecosystem and distinguishing them from traditional financial service providers.

Stablecoins and MiCA#

Stablecoins continue to be among the most significant crypto assets as they enable seamless and frictionless transfer of value across borders and economic systems. They permit users to move value between assets that may fluctuate in price to stable denominations for future use. However, stablecoins have risen to the top of many regulators’ crypto agendas primarily due to concerns about:

As a result, stablecoins have become a top priority on many regulators' cryptocurrency agendas, sparking debates about their role in the broader financial ecosystem.

In the United States, stablecoins gained significant regulatory attention with Facebookʻs (now Meta) Libra project. The tech giant proposed a privately managed stablecoin that could, in theory, become the predominant digital currency, raising concerns about its impact on central banksʻ monetary policy control.

Since the Libra project shuttered in 2022, the primary goal of the US regulatory stablecoin policy has been ensuring the proper collateralization and oversight of stablecoins. This shift has led stablecoin issuers to adopt practices similar to regulated financial institutions with robust custody agreements, established banking relationships, and comprehensive monitoring programs. While various regulatory agencies have contributed piecemeal regulations, the US Congress is working towards a more comprehensive regulatory framework for stablecoins.

In the EU, the Market in Crypto-Assets Regulation (MiCA) is rolling into effect and contains key stablecoins provisions. As of this writing, only Circle’s USDC and Euro stablecoin have successfully registered in the EU.

Swaps and Securities Regulation#

In-wallet token swaps have become a popular feature in many cryptocurrency wallets improving the usability of on-chain applications and enabling users to navigate bridging and cross-chain interactions.

However, this functionality has attracted regulatory scrutiny, particularly from securities regulators, attempting to apply traditional financial services regulations to wallets offering swap features. Most notably, the SEC has taken legal action against certain wallet providers alleging that these walletsʻ swap functions effectively operate as unregistered broker-dealers.

SEC v. Coinbase#

In April 2024, the SEC’s claim that Coinbase Wallet acted as a broker was dismissed. Self-custody wallets with swap functionalities generally do not meet the criteria for broker classification. The SEC's argument is based on their allegations that some assets available through these wallets are unregistered securities..

SEC v. Consensys#

Consensys proactively sued the SEC in April 2024 over whether the SEC has the legal authority to regulate MetaMask as a securities broker and issuer and was granted an expedited review by the judge in the case. The expedited court proceedings could lead to a decision by the end of this year.

Despite this lawsuit and losing the Coinbase v SEC lawsuit, the SEC filed a Wells Notice against Consensys at the end of June 2024. The SEC alleged that Consensys acted as an unregistered broker of crypto asset securities through MetaMask Swaps and through its crypto staking program, MetaMask Staking.

Future Implications#

While wallets will continue to be at the forefront of debates over illicit finance and self-custody, much of the future regulatory conversation will pivot to the question of decentralization. For the past few years, the crypto industry has leveraged the concept of decentralization to explain to regulators why traditional financial securities regulations should not apply to crypto services. This argument specifically addresses the questions of control and responsible parties.

Traditional finance rules and guidance regulate intermediaries to provide consumer protection and accountability. However, a key challenge emerges: how do you achieve these objectives when the services involved are inherently not intermediaries and do not custody assets or execute operations for users?

Decentralization, both as a concept and a design goal, has helped explain why traditional financial services regulations are difficult to apply to crypto. However, we are now entering a new phase of regulatory discourse where regulators are seeking to define and apply definitions of decentralization to various services, from wallets to decentralized exchanges (DEXs) and beyond. Regulators now see an opportunity to classify many crypto services as non-decentralized or "decentralized-in-name-only." This classification stems from two main factors:

That is why the next phase of regulatory discourse will shift to the concept of control. Key questions will include: Do wallets have control over the execution of a user's operation? Do DEXs have control over how an operation is executed or filled? The crypto industry as a whole is making significant progress in developing new operational models that move beyond the notion of decentralized services and into a conversation about control, data, and privacy.

At the forefront of these advancements is the utility of trusted execution environments (TEEs). We are moving towards a market structure where operational control resides within hardware and software, rather than with service providers. In this model, service providers do not have direct control over the operations taking place nor the ability to view user orders. With this approach, the crypto industry is pioneering novel ways for financial services and communications applications to operate..

Lastly, as we shift from discussions about decentralization to more nuanced conversations about control, the concepts of execution, finality, and settlement will become increasingly important. The industry will need to define collectively:

Contributors#

Flashbots Mates: Tesa Ho, George Zhang, Reid Yager, Quintus Kilbourn, Fred, Danning Sui, Elaine Hu, Daniel Marzec.

Friends: Ivo Georgiev, Joe Huang, Nic Lin, Tina He, Nico Csgy, Eric Siu, Samuel Akpan, Brian Friel, Andre Geest, Daniel.